Jay Clayton, chairman of U.S. Securities and Exchange Commission (SEC), speaks during an SEC open meeting in Washington, D.C., U.S., on Wednesday, April 18, 2018. Clayton unveiled a new approach that will attempt to address legal and regulatory uncertainties that were largely triggered by the Labor Department's rules. Photographer: Yuri Gripas/Bloomberg
Jay Clayton: SEC chairman says proposed rule will stop brokers choosing unsuitable investments for clients © Bloomberg

Clients can receive a very different level of oversight from their financial adviser depending on whether they are a broker-dealer or a registered investment adviser (RIA). Though US regulators are trying to close this gap, some believe their efforts risk confusing investors further over the service and protection they should expect.

The term broker-dealer refers to transaction-based advisers who are concerned with executing the client’s trade. RIAs, on the other hand, are more involved with the management of a client’s investment portfolio.

Broker-dealers typically get paid by commission on transactions, whereas RIAs charge a fee for their advice. More than a decade of research suggests fees are fairer than commissions for retail clients.

Under former US president Barack Obama, the Department of Labor implemented a law to force broker-dealers to put their clients’ needs ahead of their own. However, in a pincer movement by the Trump administration and federal courts, as of this month the so-called fiduciary rule is now effectively void.

Meanwhile the Securities and Exchange Commission put forth its own rule in April this year aimed at curbing broker-dealers. Much like the DOL’s failed rule, the watchdog’s proposed “regulation best interest”, open to public comment until August 7, aims to stop broker-dealers choosing products that pay them hefty commissions when a cheaper one would have been better suited to the client. It would also stop broker-dealers calling themselves advisers if paid by commission.

Karen Barr, president of the Investment Adviser Association, believes the SEC’s proposed rule is a step in the right direction but “requires greater clarity”. She reckons the Trump administration will now put its weight behind the SEC’s efforts.

On the RIA side, advisers have been held to a fiduciary standard by the SEC under the Investment Advisers Act of 1940. That different types of adviser have been held to two vastly different legal standards has always been problematic for the industry, yet attempts to harmonise responsibilities have historically been fraught.

At a conference in Washington DC in May, SEC chairman Jay Clayton said of his agency’s proposal that “it is definitely a fiduciary principle; just like the fiduciary duty in the investment adviser space is a fiduciary principle”.

Yet one of his own commissioners thinks the regulation falls short of its goal. “ ‘Regulation best interest’ purports a minimum standard that brokers may not put their own interest before the investors but I’m not sure that it does [stop advisers from putting their own interests first],” SEC commissioner Kara Stein said at an investor conference in Atlanta earlier this month.

FT 300-ranked Edelman Financial’s chief executive Ryan Parker says: “Only RIAs can say, show and do what’s in the best interests of their clients — not only because they have a regulatory obligation, but also because they’ve constructed their entire business around the principle.”

Barbara Roper, director of investor protection at the Consumer Federation of America, questions why, under the proposed regulation, broker-dealers need merely to express that they are acting in the client’s best interests, whereas RIAs must laboriously explain that they operate as fiduciaries — a term she is convinced still does not resonate with the vast majority of retail investors.

“If I was an RIA, I’d be very concerned with the sea-change of regulation, because the tone is antagonistic towards RIAs,” says Ms Roper. “The SEC’s current proposal puts a thumb on the scale for broker-dealers.”

Frank Paré, president of industry group the Financial Planning Association, argues RIAs need to look beyond simply using their legal obligations to differentiate themselves and should focus on credentials.

“Those with a ‘certified financial planner’ designation — especially when standards are updated next year — will be serving their clients under a much higher obligation,” he says of a voluntary accreditation for financial advisers that is set and enforced by an independent exam board.

Other observers believe RIAs still have the edge over broker-dealers. Thomas Holly, Washington DC head of the US asset and wealth management practice of PwC, says: “Even with the setback experienced by the Department of Labor’s fiduciary rule, the subsequent conversations around the SEC’s proposed best-interest regulation will only help crystallise that distinction.”

Yet he agrees that within the SEC’s proposed rule there is potential for complexity: “How will firms that are dual-registered — as both a broker-dealer and an RIA — be able to explain their service offerings to clients?”

In such situations, Mr Holly worries that clients might not be able to understand their adviser’s legal obligations while executing a trade to rebalance a portfolio, for instance, or providing asset allocation advice.

Yet, as FT 300-ranked RIA Fisher Investments’ chief executive Damian Ornani puts it, even though RIAs can arguably claim the regulatory high ground, not all clients are aware of the distinction.

“Thanks to regulatory efforts over the past years, many more people today know what is a fiduciary, but it’s still a relatively unknown term — even to high net worth investors,” he says.

John Anderson, managing director of practice management solutions for the SEI Adviser Network, says some RIAs are separating their investment management fees from their financial planning fees in a bid to better demonstrate their value.

He says the regulations presume that a commission-based model is more biased in the adviser’s favour than a fee structure based on assets under management. “But there’s still an inherent bias in collecting a fee on how large the investments are that your firm manages,” argues Mr Anderson.

Fisher Investments uses its fiduciary status as a central message in its marketing. Mr Ornani says a growing awareness of the types of advisers will increase market share for many, but not all, RIAs “in a meaningful way”.

“I worry for the little guys with $50m to $100m under management,” says Mr Ornani, whose firm manages $100bn.

“A difficult regulatory environment will only exacerbate their plight. Small RIAs will continue to struggle with technology, compliance and distribution costs,” he adds — and for those advisers, regulation will not be the highest priority.

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